The Long Case for dELiA's, Inc.

Newsletter Value Investor Insight carried an interview September 29th with Stephen Roseman, who runs Thesis Capital. Since 2000,his portfolios – at three different firms, but
assuming the fee structure of Thesis Capital – have returned an average 15.9% per year after fees, vs. 7.2% for the Russell 2000, according to Value Investor Insight. Here's the excerpt from the interview in which he discusses dELiA's, Inc. (NASDAQ:DLIA), which was trading at $7.70 at the time of the interview:

SR: I got to know Delia’s originally because I owned Alloy, the teen-marketing company which spun it out near the end of last year. Delia’s is now our largest position.

The company sells juniors’ apparel, mostly to girls between the ages of 13 and 19, through catalogs, online and through Delia’s branded stores in malls. They are a cleaner, nicer version of an Abercrombie & Fitch, which basically sells sex and more-forward fashion.

One of the biggest appeals here is the company’s first-class management team. The CEO, Rob Bernard, came to Delia’s after six years as the CEO of The Limited Stores. The COO, Walter Killough, had been COO of J. Crew. The head of stores came from Gap and Old Navy. I consider this a $30 management team with a $8 stock.

Where is management putting its focus?

SR: The legacy Delia’s business that Alloy had bought was a disaster. The new team has cleaned up the portfolio of stores, getting rid of the least-efficient outlets and keeping around 50 stores that were OK, if not great. It made sense to keep them as a base from which to grow, to maintain landlord relationships and as a laboratory of what works and what doesn’t. They will eventually cycle out of the old stores and replace them with new ones.

The emphasis in the new stores they’re opening is on improving the customer experience. The new stores have twice the square footage (4,000-4,500 sq. ft) of the old stores and they’ve increased staffing levels. They’ve been much smarter about locating near retailers in the mall that serve a similar demographic. They’ve also upgraded the merchandise from what was kind of throw-away, disposable fashion to more conservative, better-quality, apparel.

How is the new strategy working? The latest quarterly earnings report wasn’t particularly encouraging.

SR: The company hugely disappointed the market because they were lighter on fresh inventory than they should have been in new stores. At the same time, the comps were against previous year’s sales that were artificially inflated because they were clearing out a lot of crap in the old stores.

This is a case where we’re betting that current performance isn’t reflecting what they’re going to do as the overhaul of the company works its way through the financials. Margins are already up nicely and there’s a tremendous amount of leverage in the model as they roll out new stores.

What are the growth ambitions?

SR: They currently have 67 Delia’s stores, and we believe they can grow square footage 25% per year – up to probably 400 to 450 stores. Because the company grew up in the direct-marketing business, they have sophisticated data to inform where, and in what order, they should open stores for maximum contribution. For example, they know for every metropolitan statistical area in the country the revenues they’re generating, by zip code, online or through their catalogs.

That type of information gives them a real advantage in opening stores, decreasing the new-store payback time and allowing them to generate better cash flow to keep funding growth. All the growth should be self-funded, with no need to raise additional capital.

With the shares trading at $7.70, how are you thinking about valuation?

SR: The market cap of the entire company is around $205 million, so after net cash of $22 million or so, the company has an enterprise value of just over $180 million. Delia’s direct catalog and online businesses should generate $170 million in revenue and $12-13 million in EBITDA next year.

Just considering the catalog and online businesses, the company is trading on an EV/EBITDA basis at a 15x multiple, which we think is reasonable. So that leaves the retail business, with $90 million or so in current revenues and great growth upside, essentially available for free. We consider that a pretty good price.

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